A business uses the accounts receivable (AR) turnover ratio to measure how well it manages the credit it extends to customers. AR turnover is essential because cash is king, and a business can only survive by regularly collecting cash to pay its expenses. 

How to Calculate AR Turnover

For example, suppose a company sells a product to a customer, and the customer immediately pays in cash. In that case, no accounts receivable are recorded because the payment was made immediately with the purchase.

Alternatively, if the company sells a product to a customer on credit with payment terms 2/10 net 30, the cash is collected at a later date. The company records an accounts receivable amount for the balance due, and once the cash is collected, it applies those cash receipts to the outstanding AR balance. 

The formula for Accounts Receivable Turnover is as follows:

AR Turnover Ratio = Net Credit Sales for Period / Average Accounts Receivables for the Period

The period is generally a full year (365 days) but can be shorter or longer. For example, let’s say a company wants to calculate its AR turnover for the first three months of its fiscal year, January 1, 2023, to March 31, 2023. The company’s details are as follows:

  1. The accounts receivable balance at December 31, 2022, is $15,000.
  2. The accounts receivable balance at March 31, 2023, is $29,500.
  3. Total sales for the first three months are $500,000. Cash sales were $400,000, and credit sales were $100,000.
  4. Cash collected on AR was $85,500 during the 1st quarter of 2023.

AR Turnover Ratio = 100,000 / ((15,000 + 29,500) / 2)

The Company’s AR Turnover Ratio = 4.49

A company generally prefers a higher AR turnover versus a lower ratio. Higher ratios indicate that sales extended on credit are collected quickly. Fast collections happen for a variety of reasons. The company may only extend credit to a select group of customers, or it may be very aggressive in following up for payments.